BALTIMORE (Stockpickr) -- Don't let yesterday's whopping 2.4% rally in the S&P 500 fool you -- there's still a whole lot of risk baked into the stock market right now.
In the last two trading sessions, the S&P 500 has reclaimed all but 87 basis points of its early-December correction. That means shares are within grabbing distance of all-time highs again to end the year, thanks primarily to the Fed's interest rate comments on Wednesday. But the VIX Volatility Index remains on the high-end of its 3-year range this week.
More importantly, Average True Range, a statistical measure of volatility in the market, is racing up to test new post-2011 highs this month. Translation: risk is on the rise again. And that means that you need to cut ties with the stocks that look "toxic" here. That's why we're taking a technical look at five toxic stocks you should sell (or short) in December…
Just to be clear, the companies I'm talking about today aren't exactly junk. By that, I mean they're not next up in line at bankruptcy court. But that's frankly irrelevant; from a technical analysis standpoint, sellers are shoving around these toxic stocks right now. For that reason, fundamental investors need to decide how long they're willing to take the pain if they want to hold onto these firms in the weeks and months ahead. And for investors looking to buy one of these positions, it makes sense to wait for more favorable technical conditions (and a lower share price) before piling in.
For the unfamiliar, technical analysis is a way for investors to quantify qualitative factors, such as investor psychology, based on a stock's price action and trends. Once the domain of cloistered trading teams on Wall Street, technicals can help top traders make consistently profitable trades and can aid fundamental investors in better
So, without further ado, let's take a look at five "toxic stocks" you should be unloading.
Up first is small-cap fragrance stock Inter Parfums (IPAR) , a name that's been no stranger to downside risk in 2014: shares of the New York-based perfume company have tumbled 23.4% year-to-date, underperforming the S&P 500 by more than 34% since the calendar flipped to January. Put simply, IPAR has been stinking up investors' performance this year. And it could be about to get worse…
That's because IPAR is currently forming a descending triangle pattern, a bearish technical setup that's formed by horizontal support below shares (at $25.50 in Inter Parfums' case), and downtrending resistance to the upside. Basically, as IPAR bounces in between those two technically important price levels, it's been getting squeezed closer to a breakdown below that $25.50 price floor. If that line in the sand gets violated, then we've got a new sell signal in IPAR.
Momentum is the side-indicator to watch in IPAR. 14-day RSI, our momentum gauge, has been slowly bleeding lower long-term, an indication that buying pressure is continuing to wane in IPAR. If $25.50 gets violated, look out below.
We're seeing a very similar setup in shares of high-profile technology stock Nokia (NOK). While NOK has spent much of the year in rally mode, climbing more than 20% from its February lows, shares broke their uptrend at the start of December. Now, Nokia is forming a descending triangle of its own, and the breakdown level to watch is $7.60…
Why all of the significance at $7.60? It's not magic. Whenever you're looking at any technical price pattern, it's critical to keep buyers and sellers in mind. Patterns like the descending triangle are a good way to quickly describe what's going on in a stock, but they're not the reason it's tradable -- instead, it all comes down to supply and demand for NOK's shares.
That $7.60 level in NOK is the spot where there's previously been an excess of demand for shares; in other words, it's a price where buyers have been more eager to step in and buy shares at a lower price than sellers were to sell. That's what makes a breakdown below support so significant -- the move means that sellers are finally strong enough to absorb all of the excess demand at the at price level. A violation of $7.60 means that a whole lot of downside risk just opened up in Nokia.
Energy stocks have gotten a pretty noticeable break from selling this week, but don't mistake that for a change in trend. In fact, the downtrend is alive and well in many energy names this month, including mid-cap E&P stock Rice Energy (RICE) . You don't need to be an expert technical analyst to spot the well-defined downtrend in shares of RICE, and as shares test resistance for a sixth time this year, it makes sense to sell the next bounce lower.
Waiting for that bounce lower before clicking "sell" is a critical part of risk management for two big reasons: it's the spot where prices are the highest within the channel, and alternatively it's the spot where you'll get the first indication that the downtrend is ending. Remember, all trend lines do eventually break, but by actually waiting for the bounce to happen first, you're confirming that sellers are still in control before you unload shares of RICE.
Relative strength adds another red flag to the setup in RICE. This stock's relative strength line has been trending lower since the summer (just like price), telling us that RICE is underperforming the broad market here. As long as the downtrend in relative strength remains intact, Rice Energy's underperformance should continue.
Chinese stocks have been under pressure for much of 2014, and Chinese real estate services stock E-House Holdings (EJ) has been no exception. Since the start of the year, shares have capitulated to the tune of 51%. That's huge underperformance in a market environment that's up double-digits. And with a recent violation of a key level this week, shares look ready to kick off another leg down.
EJ is currently forming a head and shoulders top, a setup that indicates exhaustion among buyers. The pattern is formed by two swing highs that top out at approximately the same level (the shoulders), separated by a higher high (the head). The sell signal came on a move through E-House's neckline at $9. Even though EJ's head and shoulders isn't "textbook" (because it shows up at the bottom of this stock's recent range, not the top), the trading implications are exactly the same here.
Based on the minimum measuring objective in EJ, shares could move down to $6 before this stock can catch a bid again. If you decide to go short here, it makes sense to park a protective stop at the 50-day moving average.
Last up on our list of potentially toxic names is CSX Corp. (CSX) , a railroad operator that's been chugging higher for most of 2014: shares are up more than 25% since the beginning of January. But after a lengthy move higher, investors might want to think about taking gains here. That's because CSX is another stock that's showing signs of a classic head and shoulders top in shares.
The top in CSX isn't quite as far along as the one in EJ -- the sell signal triggers on a violation of CSX's neckline level down at $34.50.
Lest you think that the head and shoulders is too well known to be worth trading, the research suggests otherwise: a recent academic study conducted by the Federal Reserve Board of New York found that the results of 10,000 computer-simulated head-and-shoulders trades resulted in "profits [that] would have been both statistically and economically significant."
That's good reason to keep an eye on the downside risk in EJ and CSX this week.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory that returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.
Follow Jonas on Twitter @JonasElmerraji